BCB Preview: The risk is fiscal weakness depreciating the real – TDS

The Central Bank of Brazil (BCB) is widely expected to keep rates on hold at 2%. The need for monetary support plays against future fiscal risks that may force monetary policy action earlier than expected. Meanwhile, BRL continues to be challenged by low rates and an unconstructive underlying balance of payments position, however, the October meeting is unlikely to be relevant for BRL, according to economists at TD Securities.

Key quotes

“For Brazil, the inflation complex holds little threat for the policy stance of its own accord. However, the risk that fiscal weakness forces a rapid expansion in risk premium in Brazilian longer-term assets and the currency is real. This could spur the BCB to act against a rapidly depreciating BRL in order to stabilize inflation expectations and mitigate the supply shock to tradeable prices. While we don't think that this is a likely policy-driver until the actual issue materializes, we do expect the BCB to continue to flag this risk and perhaps increasingly emphasize its importance in the monetary policy outlook.”

“BRL's position has been substantially helped by the deterioration in domestic demand and consequent improvement in the current account deficit. Portfolio flows have not been supportive, however, and remain a risk to BRL should fiscal risk premium continue to increase and force currency weakness.”

“The real risk for BRL is a fiscal risk premium-driven depreciatory spiral, that would ultimately force the central bank to act on the short end of the rates curve to stabilize the currency. We do not believe that the FX market prices this in, though the rates market certainly does to some extent.”